Credit, Banking's Essence, Set for Rethinking: Borrowers Need Credit and Banks and Other Lenders Need to Make Loans. How Did Things Go Wrong from There?

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A series looking at how U.S. banking has changed, may change, and will change in the wake of the 2008 crisis. This month begins the series with a first look at credit.

Former banker Bill Barksdale is either a card-carrying cynic, or, at least, a realist with a respect for history. When he retired from a senior vice-presidency at Wachovia in 1997, he sold his company shares shortly thereafter.

Friends asked him why. "I was in the risk management business for 30 years," Barksdale told them, "and I know that every 12 years or so, lenders screw it up."

Retired Wachovia chief John Medlin used to say, "Real estate is the cocaine of the banking business," says Barksdale. Invariably, he says, real estate somehow underlies many periods of credit turmoil, and it's not unusual for many to get religion.

"Every time you have a blowout," says the veteran banker, who still teaches some credit courses, "there is an 'How did we ever get led astray? It's back to basics!' movement." However, he says if many of the aphorisms of the credit business had been heeded, it would have kept the nation's lenders out of trouble.

Case in point was a Barksdale favorite: "Show me a deal that's too good to be true, and I'll show you a deal that isn't true."

How much rot has been exposed? And how much remains to be?

Breakdown of basics

Alas, Barksdale is spot on. Other veterans among bankers, consultants, and former regulators interviewed agree that some of what the industry and the nation are seeing these days is a cyclical reckoning for excess. But others agree with his other point, as well, and see today's conditions as a result of a breakdown of fundamentals that is going to take a great deal of pain to fix.

Take Bert Ely, principal of Ely & Co., Alexandria, Va.

"Our financial system has been built on a platform of myths and regulatory arbitrage, and that platform is collapsing," says Ely. "We're facing absolutely enormous changes." Ely predicts that 2009, when Congress is expected to consider the financial regulatory system, will turn out to be the most significant legislative year for banking since the 1930s.

What bankers have been watching in recent weeks "is shaping up to be worse than the S&L crisis," says Nicholas J. Ketcha, Jr., principal now at consultancy FinPro, Inc., Liberty Corner, N.J., and previously director of the N.J. Division of Banks, and FDIC Director of Supervision. "This is going to be the biggest downturn in the economy in a while," continues Ketcha, and comes down to a liquidity-eroding crisis of confidence.

How'd we get here?

The blame game is something that Congress will spend much time on, in the months and years ahead. It could be argued that we all own a piece of something that became inevitable; an economy that was 70% driven by consumer spending coupled with a fair amount of irresponsible borrowing and lending, with people often living beyond their means, was headed for trouble.

"This is a matter of people going where they thought they would find money," for what have you, says a longtime observer of the credit scene.

Homeownership is one example: "We've got the notion in the U.S. that everyone needs to own a home," says the veteran, preferring not to be quoted by name. While such societal attitudes play a part, so do some structural issues.

The panorama of companies that lend money in modern America is wide, but one factor used to be fairly common among the players: the lending officer who found a loan evaluated the loan, and, after other officers or committees passed on it, lived with the loan.

Increasingly, those roles have been busted apart, both internally and externally. Think of internal "silos." Think of securitization. Think of loan brokers versus loan officers.